Private Credit Explained: Benefits, Risk, and Access

Private Credit Explained: Potential Benefits, Risks, and Ways to Invest
Private credit has grown into a significant segment of the global lending market, but many investors still have questions about what it is, why it has expanded, and how it may fit within a diversified portfolio.

To explore the asset class, David Wagner of Tidecrest Wealth Management spoke with Jeff Willardson, co-founder and managing partner of Ghost Tree Partners. Willardson has more than two decades of experience in credit and alternative investments, with a particular focus on institutional portfolio construction.

Their conversation covered the fundamentals of private credit, the reasons borrowers seek non-bank financing, the potential benefits and risks for investors, and the structures commonly used to access the market.

What Is Private Credit?
Private credit generally refers to loans made by non-bank lenders to privately held businesses, projects, or other borrowers.

Unlike publicly traded bonds, these loans are typically negotiated directly between the borrower and lender. Their terms may be customized around the borrower’s financial condition, collateral, cash flow, and capital needs.

Private credit can include:

• Senior secured loans
• Direct lending
• Asset-based lending
• Mezzanine or subordinated debt
• Real estate credit
• Specialty finance
• Distressed or opportunistic credit

The position of a loan within a borrower’s capital structure matters. A senior secured lender generally has a higher-priority claim on specified collateral than subordinated lenders or equity owners. That priority may provide a degree of protection, but it does not eliminate the possibility of loss.

Why Has Private Credit Expanded?
Banks have traditionally supplied much of the financing needed by privately held businesses.

Following changes in banking regulations, capital requirements, and institutional risk limits, some banks became more selective about the borrowers and loans they were willing to support. At the same time, businesses continued to need capital for acquisitions, inventory, expansion, refinancing, and other purposes.

Non-bank lenders entered portions of the market where traditional financing was limited or unavailable.

Private lenders may be able to evaluate situations that do not fit standardized bank-underwriting criteria. In exchange for providing customized financing, they may negotiate higher interest rates, collateral rights, financial covenants, or other lender protections.

For borrowers, the appeal can include speed, flexibility, and access to capital. For investors, the appeal may include income and exposure to loans unavailable in public bond markets.

How Private Lending Can Work
During the interview, Willardson described a loan involving an established retailer that experienced a substantial decline in revenue during the pandemic.

The company’s historical bank was no longer willing to extend additional credit, but the business needed capital to purchase inventory and continue operating.

A private lender could evaluate more than the company’s recent earnings. It could also consider the value of its inventory, real estate interests, expected tax-related receivables, and the potential recovery of its underlying business.

The resulting loan could be secured by specific assets and structured with contractual protections.

This illustrates one distinction between private and conventional lending. Private lenders may have greater flexibility to construct a loan around a borrower’s specific assets and circumstances.

However, collateral should not be mistaken for a guarantee. Recovering assets after a default can be costly and time-consuming, and their liquidation value may be significantly lower than expected.

Why Investors Consider Private Credit
Private credit may offer several potential portfolio benefits.

Income potential
Privately negotiated loans may provide higher interest income than certain publicly traded bonds. This potential premium can compensate investors for accepting illiquidity, complexity, credit risk, and limited transparency.

The amount of income ultimately received depends on borrower performance, defaults, fees, financing costs, and the investment structure.

Floating interest rates
Many private loans use floating interest rates. Their stated yields may rise or fall as an underlying reference rate changes.

Floating rates may reduce some forms of interest-rate sensitivity, but higher borrowing costs can also place additional pressure on borrowers and increase default risk.

Portfolio diversification
Private loans may behave differently from publicly traded stocks and bonds because they are not continuously priced in public markets.

That does not mean they are immune to economic conditions or market losses. Private borrowers are still affected by recessions, interest rates, inflation, tariffs, competition, and changing consumer demand.

Private valuations may also adjust less frequently than public-market prices. Apparent stability can partly reflect the valuation process rather than an absence of economic risk.

Customized lender protections
Private lenders may negotiate financial covenants, collateral claims, reporting requirements, and restrictions on borrower activity.

These protections can give lenders greater influence if a borrower’s financial condition deteriorates. Their effectiveness depends on the quality of the underwriting, documentation, collateral, and enforcement process.

The Primary Risks of Private Credit
Potentially higher income does not come without trade-offs.

Credit and default risk
Private-credit borrowers are frequently smaller or more highly leveraged than public investment-grade companies. They may have fewer products, customers, or sources of capital.

An economic downturn or company-specific problem can therefore have a significant effect on their ability to repay a loan.

Before investing, it is important to understand:

• The quality and diversification of the borrowers
• Their leverage and interest coverage
• The lender’s underwriting standards
• The collateral supporting the loans
• Historical defaults and recoveries
• How problem loans are managed

Illiquidity
Private loans generally do not trade in a deep, continuous secondary market.

An investor may need to hold the investment for several years. If an early sale is possible, the available price may be substantially below the value previously reported.

This makes private credit inappropriate for money needed to fund near-term spending, taxes, emergencies, or other foreseeable obligations.

Valuation risk
Without regular market transactions, private loans may be valued using internal models, third-party estimates, or periodic appraisals.

Reported values can therefore appear less volatile than publicly traded bonds. Investors should not assume that smoother reported returns necessarily mean lower underlying economic risk.

Structural and liquidity mismatch
Some private-credit vehicles invest in long-term, illiquid loans while offering investors periodic opportunities to request redemptions.

Those redemption programs may be limited, suspended, prorated, or subject to gates. The ability to request quarterly liquidity is not the same thing as a guarantee that the investment can be redeemed when desired.

Investors should compare the liquidity promised by the vehicle with the liquidity of the underlying assets.

Fees and leverage
Private-credit strategies may charge management fees, incentive fees, administrative expenses, and other fund-level costs. Some vehicles also borrow money to increase their investment exposure.

Leverage can increase income when loans perform as expected, but it can magnify losses and create additional liquidity pressure during difficult markets.

The evaluation should focus on expected results after all fees, expenses, defaults, and financing costs.

How Investors Access Private Credit
Private credit is available through several structures, each with different characteristics.

Business development companies
Business development companies, commonly called BDCs, generally invest in debt and equity issued by smaller and middle-market businesses.

Some BDCs trade publicly, while others are non-traded. Publicly traded BDCs may provide daily liquidity, but their market prices can fluctuate substantially and trade above or below the reported value of their underlying assets.

Interval funds
Interval funds generally offer to repurchase a limited percentage of their outstanding shares at predetermined intervals.

They may provide broader access to private investments, but investors should understand that redemption capacity is limited. Requests may be prorated when demand exceeds the amount the fund has offered to repurchase.

Private funds
Private-credit funds may raise capital from accredited investors or qualified purchasers and invest that capital over a defined period.

These vehicles frequently require multiyear commitments and may issue capital calls. Investors should understand the fund’s strategy, term, fees, borrowing arrangements, distribution policy, and restrictions on transfers or redemptions.

Separately managed or institutional structures
Larger investors may access private credit through customized accounts, co-investments, or institutional partnerships.

These arrangements can offer greater control but usually require substantial capital, specialized due diligence, and ongoing oversight.

Questions to Ask Before Investing
Before allocating capital to private credit, investors should ask:

• What types of borrowers and loans does the strategy target?
• Where do the loans sit within the capital structure?
• What collateral and covenants protect the lender?
• How diversified is the loan portfolio?
• How are investments valued?
• How much leverage does the fund or vehicle use?
• What are the management and incentive fees?
• How long should investors expect their capital to remain committed?
• Can redemption requests be limited or suspended?
• What happens when a borrower defaults?
• Does the manager have experience working through full credit cycles?
• How does the allocation affect the liquidity of the overall portfolio?

The manager’s underwriting and servicing capabilities are especially important. In private credit, selecting and negotiating the loan is only the beginning. The lender must also monitor the borrower and respond effectively if financial conditions deteriorate.

Where Private Credit May Fit in a Portfolio
Private credit should be evaluated as part of the investor’s complete asset allocation—not simply as a higher-yielding substitute for traditional bonds.

An appropriate allocation depends on:

• The investor’s income needs
• Capacity for loss
• Time horizon
• Existing fixed-income exposure
• Alternative-investment exposure
• Tax circumstances
• Near-term liquidity requirements
• Comfort with complex and less transparent investments

Private credit may provide income and differentiated exposure, but investors must be compensated for accepting illiquidity, credit risk, valuation uncertainty, and additional complexity.

The central question is not whether private credit is inherently good or bad. It is whether a particular strategy, manager, and investment structure serve a clearly defined role within the portfolio.

Learn More About Private-Market Investing
Tidecrest Wealth Management helps families evaluate private-market opportunities within the context of their complete investment, tax, liquidity, and long-term planning needs.

If you are considering private credit or reviewing an existing alternative-investment allocation, we invite you to learn more about our approach and schedule a conversation with our team.

This material is provided for educational purposes only and should not be considered an offer, solicitation, or individualized recommendation to invest in private credit or any other security. The views attributed to Jeff Willardson are his own and do not necessarily represent the views of Tidecrest Wealth Management. Private-credit investments involve substantial risks, including credit loss, illiquidity, limited transparency, valuation uncertainty, leverage, and loss of principal. Past performance does not guarantee future results.